Usually a fund house disseminates the performance of its schemes relative to a benchmark. Is it the right way to measure a fund’s performance? Should one look for other criteria?
Amrita was very happy that the fund in which she had invested Rs 1 lakh had managed a mind-boggling return of 50 per cent in one year. In comparison the benchmark index had given a return of 35 per cent. She happened to meet Maya, an investment analyst.
While sharing her experience with Maya, she was surprised to know that there were at least 30 other schemes that had given a return of more than 50 per cent. Do you have a similar predicament?
Returns and benchmark
There are many ways to measure the performance of an equity fund. The most basic method is to check the performance of the fund against its benchmark.
In case of equity funds, the benchmark is usually an index such as the BSE Sensex or the Nifty. For sector funds such as pharma or IT funds, it is sectoral indices such as BSE Healthcare Index or CNX IT index that are the correct benchmarks. These indices are a collection of stocks that, together, are meant to represent the equity market. For example, the BSE Sensex is a weighted average of prices of 30 select stocks and S&P CNX Nifty of 50 select stocks.
The fund manager’s responsibility is to manage his portfolio in such a manner that over time, he or she is able to generate returns that are superior to that of the benchmark indices. Each fund chooses a particular benchmark index and tries to outperform it. So, while checking the performance of your actively managed fund, do check how it performs against its benchmark.
You can assess the performance of your mutual fund investment by computing appreciation in the NAV of the scheme over different periods of time, against relevant benchmarks. Another significance of the benchmark is that it gives you a rough indication as to what kind of stocks the fund is likely to invest in. Various types of benchmarks
Equity-oriented funds are usually benchmarked against the CNX Nifty, CNX Nifty Junior, CNX 100, CNX 500 and CNX Midcap indices maintained by the NSE or against the Sensex, BSE Midcap, BSE 100 or 200 maintained by the BSE.
Debt funds, Balanced funds and Monthly Income Plans are usually measured against either benchmarks created by CRISIL or against blended (combinations of existing indices) indices constructed by the fund house. Are benchmarks best standards?
However, the stated benchmarks are not always the best standard for performance evaluation as many a time funds take liberties while managing the fund. There are times when the fund managers invest actively in stocks outside the benchmark, in order to maximise their returns. At times, the fund may also invest in a class of stocks that are not correctly reflected in the benchmark.
A fund supposed to invest in large-cap stocks (stocks with high market capitalisation) may dabble in mid-cap or small-cap stocks, to improve returns. These investments entail taking higher risk as mid-cap and small-cap stocks are subject to greater volatility compared to large caps.
As the number of schemes in the market increases, fund houses have been coming out with ‘thematic’ schemes to attract investors. For example, if infrastructure stocks are the flavour of the season, you see fund houses launching infrastructure funds. When you compare their returns with the large-cap indices, they often deliver superlative returns. But the returns may not appear in such good light compared to a sector index such as the BSE Capital Goods.
Benchmark comparisons also have to factor in how challenging the year has been for the peer group. A fund may have outperformed the benchmark by a small margin when all its peers have comfortably trounced the index. In such a case, outperformance against the benchmark may not be of much comfort to the investor.
(Mr.A. V. Pai is a Mumbai-based freelance writer.)
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